How to Play Chipotle Mexican Grill Ahead of Earnings

While the direction of the post-earnings move is uncertain, it's likely the options are under-pricing its magnitude.

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MINYANVILLE ORIGINAL Chipotle Mexican Grill (NYSE:CMG) reports on Thursday after the close. You may recall that it was the only "unshortable short" that I actually shorted (through options) about $120 higher. Has the beating been enough? Longer term, I'm pretty sure the answer is no, but let's take it one quarter at a time. And for this quarter you can rest assured that management will do whatever it takes to put lipstick on the results.

But while I'm unsure of the direction of the post-earnings move, I am pretty confident the options are under-pricing its magnitude. The October at-the-money options, which will have only one day to react, imply a 6.5% move between Thursday and Friday. November expiration is pricing an 8.5% move. Come Thursday morning, we will also have the October 25 weeklies out, and we'll see what they suggest. In any event, the average post EPS one-day change for Chipotle since 2006 is 7.65%, which alone is more than what's priced in the October options.

And this is no "normal" stock or "normal" quarter. Despite the recent collapse, it remains very much a cult affair for those who believe they have discovered the "restaurant stock that will never stop growing." On the other side of the battleground, which includes the likes of David Einhorn, are those who believe that "this time is not different," and that Chipotle will eventually trade at normal restaurant multiples -- about 23x EPS, or 30% below Chipotle's current P/E. Put 23x on 2013 estimates and you get $250. If estimates go down, which very well might happen once Chipotle has to re-up its food hedges, that multiple will prove way too generous. This particular report will go a long way toward either burying the longs or giving them new life, and giving the shorts a good drubbing (short interest is pretty high).

So, long story short, here is how I'm playing it: I'm going to go into the release long stock and long Nov. 280 puts on a "delta neutral" basis. I've also pressed the downside with a 1x2 put spread on the October 250/235 which forces me to cover my entire short exposure at $220 if that's where the stock trades on Friday. The spread was put on at even money. If the results are good I can see the stock fly back toward the $350 area. If I waited out November expiration my breakeven on the upside is about $320.

Tune in Thursday afternoon for an old-fashioned Animal House food fight.

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